Inside Man

Congress members accuse Timothy Geithner of coddling Wall Street. Wall Street accuses him of abetting socialism. Yet when the history books are written, Geithner will be recognized as Barack Obama’s key lieutenant in the struggle to right the economy and fix the finance system. Economically, Geithner’s plan has worked better and more cheaply than anyone could have imagined a year ago. Politically, it threatens to undermine Obama’s presidency. Is Geithner a courageous public servant doing the right thing? Or have his years as a player in global finance made him loath to change an industry that needs fundamental reform?

According to insiders, Geithner and Summers faced off last year over whether or not to fire Ken Lewis, then CEO of Bank of America. (Summers denies this.) Lewis led the ill-fated acquisition of Merrill Lynch, which saddled his bank with huge losses and necessitated three separate government bailouts. Ousting him for poor performance, as Summers wanted to do, would have been good politics (shareholder wrath finally drove Lewis out in December). But Geithner opposed this, on the grounds that the stress tests promised Bank of America the opportunity to raise private capital, and that removing Lewis prematurely would likely upset the markets, making it harder for other banks to raise money. Geithner won. “I argued,” he told me, “‘There’s a basic principle, Mr. President, which is that if, at the end of the stress tests, these guys need a huge amount of capital and they can’t raise it in the market, and we have to put it in then we will change management.’” Making an example of Lewis would be premature and indulgent. “In a crisis, you have to choose,” Geithner told me. “Are you going to solve the problem, or are you going to teach people a lesson? They’re in direct conflict.”

Geithner plainly has no patience for what he describes as the obdurate unwillingness of colleagues to subordinate their desire for superficial impact to the larger vision. “That’s exactly the dilemma,” he said. “The stuff that seemed appealing in terms of sharp discontinuity, Old Testament justice, clean break, fix the thing, penalize the venal, would have been dramatically damaging to the basic strategy of putting out the panic, getting growth back, making people feel more confident in the future—solving it without putting trillions of dollars of the taxpayers’ money at risk unnecessarily.”

All of this is extremely interesting because of what it seems to reveal about each man: Summers, whose knock has always been that he’s an academic trapped in a world of theory, has become the politically minded one, while Geithner, the savvy realist, now evinces rigorous fealty to an idea. But it’s even more interesting for what it says about Obama. At every turn, he has sided with Geithner.

In late December, the Commerce Department reported that the economy grew at a rate of 2.2 percent in the third quarter, ending four straight quarters of decline. (That figure leapt to 5.7 percent in the fourth quarter.) Then, later that day, Obama told The Washington Post in an Oval Office interview that the most important thing he’d accomplished in his first year was “to ensure that the financial system did not collapse.” Then Geithner went on NPR and stated flatly that there would be no double-dip recession—by Washington standards of caution, a provocative move. Even with unemployment high and anger at Wall Street intense, the mood at Treasury is quietly exultant because the imminent possibility of another depression has disappeared and growth has resumed, all at a fraction of the cost estimates being bandied about last year when it still looked like the government might need to take over large banks.

Geithner likes to point out that after a year on the job, he’s spent $7 billion recapitalizing financial firms while private investors have put up $140 billion. TARP money is being repaid faster than anyone imagined, and if Obama gets the $90 billion tax on big banks he proposed in January, it could eventually be recouped. It’s likely that the cost to taxpayers will be much less than the 5 to 10 percent of GDP that the Cleveland Fed says is typical for a crisis, and possibly as little as 2 to 4 percent—about the cost of the much smaller savings-and-loan crisis of the 1980s. A recent Treasury study indicates that it could be less than 1 percent. By any reasonable standard, this would be an impressive achievement, and it would owe a great deal to Geithner’s strategy.

And yet, a year into his presidency, the overwhelming criticism of Obama is that he is taking too much control of the economy and spending too much money—which must really sting, because by avoiding nationalization and its colossal costs, he has probably saved an incredible sum. “We’re getting killed from the right and from the left on the basic strategy,” Geithner told me. “The right argues that we unnecessarily socialized the entire financial system. The left says we wasted money on things they’d have rather used to help real people directly. As you might understand, I have no sympathy with either. Neither critique is right. To the right, I would say: ‘No, the strategy we adopted was overwhelmingly designed to try to make sure that private markets came and took us out of this as quickly as possible. That was a conscious choice, a shift in strategy, and a more pro-market approach that will help us deal with our fiscal challenges.’ And to the left, I would say: ‘And that saved the taxpayer hundreds of billions of dollars that you can use to meet the main challenges we face as a country—health care, education, infrastructure, and our long-term deficit.’”

But Geithner’s achievement is appreciated in the Oval Office, where he is viewed as the architect of a successful turnaround. “Tim presented his course in a forceful way, and that’s the course the president picked,” Rahm Emanuel told me. “At the end of the day, it saved the United States taxpayer a trillion dollars.” This is why, I think, despite the public clamor for his head, Geithner came across to me as confident and brash—almost unnervingly so—even after the Republican upset in Massachusetts. If you believe, as most people in Washington do, that the economy will be the chief determinant of Obama’s political fortunes, then Geithner, by having shaped the president’s response to the crisis more than anyone else, would have to rank as Obama’s most influential adviser. This would put him right back in the familiar role he has so often inhabited in his career. One indication of this is that nobody calls it the Geithner Plan anymore—now, it’s “the president’s economic policy.”

The second of the two critical steps for the Obama administration in responding to the crisis is fixing the system, and Washington has taken it up in earnest. Geithner is at the heart of this process too, although the public has lately been led to believe that he isn’t. Last year, Geithner and Summers designed the administration’s reform plan (on which they seemed to see eye to eye), which drew healthy criticism, including Paul Volcker’s, for being soft on Wall Street. After the Massachusetts loss, Obama made a show of introducing additional “tough” new rules, bringing back Volcker to lend him credibility and endorse constraints on future bank growth and on banks’ ability to bet on risky assets like hedge funds—an episode widely interpreted as a rebuke to Geithner. For political purposes, it was. But in truth, the new measures were relatively small ones rushed forward to appease a hostile electorate. (And Obama had Geithner design them.) For better or worse, whatever Congress passes will be based on the plan Geithner and Summers drew up last year—a version of it already passed the House of Representatives in December, and will need amending to include any new rules. At this point, Obama can adjust his rhetoric to be tougher on Wall Street, but he can’t do much to adjust his plan. That die has been cast.

Last June, Treasury published a paper laying out proposals for financial reform, and then, in the fall, when everyone was absorbed in the health-care debate, took the additional step of drafting legislation—noteworthy because whoever writes the legislation also establishes the terms of debate. With the administration’s other major undertakings so far, the stimulus package and health-care reform, the White House ceded the task to Congress. But on financial reform, Congress took up the Treasury blueprint.

When Obama unveiled the plan, he called it the most sweeping set of reforms since the New Deal, which implies more than it should, because the “reforms” of the past three decades have mostly entailed dismantling regulations. A more salient assessment would weigh the reform plan against alternatives. The journalist Ronald Brownstein has likened the conceptual divide among proponents of financial reform to the one between Cold War strategists confronting the Soviet Union: one camp favors “rollback,” the other “containment.” Geithner is a containment guy to the core, and the plan reflects this.

One source of criticism is that it’s milder than the ones Geithner and his Clinton colleagues forced on Mexico, Thailand, and other emerging-market countries in the 1990s. The plan is more along the lines of the derivative reforms Geithner pursued at the New York Fed, which were intended to strengthen the system while leaving it fundamentally intact.

The Treasury reforms would impose constraints on the leverage that firms could use, so the risks they take wouldn’t be quite so extreme. They would increase, but not radically, the amount of capital that firms must hold, so that institutions could absorb greater losses before turning to the government. They would establish a clearinghouse for trading derivatives, to make the process less murky and the systemic risks more apparent. They would empower shareholders to express displeasure over how much bankers are paid, but would not limit that pay or interfere with bonuses. They would establish a Consumer Financial Protection Agency (although the prospects for congressional approval of this look dim). They would require large firms to have “living wills”—essentially, blueprints of their structure and investments—so that if they failed, the government could shut them down without sparking a panic. And they would expand oversight of the financial system, partly by investing more power in the Federal Reserve.

What they wouldn’t do is break up big banks or set size limits that would force big banks to shrink. Nor would they eliminate the possibility of future bailouts: they would in fact give Treasury new powers to intervene. They wouldn’t meaningfully penalize any of the major regulatory agencies that failed so miserably the last time around (although they would eliminate a small one). And they would do nothing so radical as reinstate the Glass-Steagall Act, which separated commercial from investment banking (Volcker has advocated doing this), or for that matter any of the other major banking regulations repealed after 1980. In other words, they wouldn’t do what most people would like them to, which is to actively reshape the financial world into something much different from the one that collapsed.

In this sense, they didn’t satisfy Rahm Emanuel’s famous declaration, “You never want a serious crisis to go to waste,” which seemed to promise reforms as ambitious as the rescue effort. The Wall Street that would exist if the administration’s reforms were put into place would be safer, saner, and more easily managed if the government had to step in. But it wouldn’t look a whole lot different than it does today, and neither would the government.

“The overarching approach of the Obama administration,” Vincent Reinhart, a former Federal Reserve official who is a scholar at the American Enterprise Institute, told me, “is to try to assess where are the market and political constraints on their range of actions, and then find solutions comfortably within those constraints. But now is the time to be a demagogue about reforming financial institutions, and they’re not investing any political capital in trying to push out those constraints. When you try so hard to preserve the existing order, you may in fact risk its long-term health.” Even the measures introduced in January would have only modest effects. The limit on bank size, for instance, would not force a single existing bank to shrink. Indeed, for all its sensible elements, what’s most striking about the administration’s plan is how thoroughly it would keep intact the two worlds Geithner knows best, Wall Street and Washington.

The reform debate is about how best to protect against the catastrophic failure of big banks. “Never again,” Obama vowed in January, “will the American taxpayer be held hostage by a bank that is too big to fail.” The debate pits one group of people who believe that big banks must be broken up, against another who believe that rules can be devised to limit the risk they pose and leave them intact. “It’s risk, not size, that matters,” Geithner told me. The main criticism of Obama’s plan is that it’s too modest about containing risk, and violates his pledge to prevent the conditions for another crisis. By leaving dangerously large institutions not only intact but emboldened by the belief that government will rescue them if they get into trouble, the critics say, he is setting the stage for exactly that. Size matters.

The administration’s most energetic critic, the MIT business professor Simon Johnson, is an outspoken member of the “rollback” crowd. Johnson’s criticism is the more notable because he happens to share with Geithner the experience of having battled emerging-market financial crises from inside the International Monetary Fund (he was chief economist several years after Geithner departed for the New York Fed).

Johnson contends that Team Obama has ignored the necessary step of breaking up the power of what he calls the “oligarchies”—the big Wall Street banks—as part of the reform process, which is what happened after the emerging-market crises. “If your banks have run themselves into the ground doing crazy things,” he told me, “you need a substantial shift in the power structure. In the ’90s view, the Geithner-Summers view, it is essential that you address that problem as part of the immediate stabilization policies.” To Johnson, as ardent a believer in regulatory capture as George Stigler ever was, it’s plain that Geithner has fallen under Wall Street’s spell, and that through him and his whole apparat, Obama has too.

Geithner disputes this, of course. “We may sometimes look like it,” he told me, “but the United States is not an emerging market.” The disagreement over reform comes down to a difference of opinion about whether the United States’ economic and financial predicament really is as bad as that of an emerging market, or whether it’s bad, but not so bad that the banks need to be broken up. Geithner convinced Obama—and Volcker has not yet convinced him otherwise—that modesty is the best policy.

What can’t be disputed is that the decision to focus on risk management rather than size carries the same political disadvantages Geithner’s plan for recovery did. By allowing Wall Street’s major institutions to continue unmolested—even as they exploit the government’s guarantee by paying themselves huge bonuses—the administration appears weak and indulgent, and deaf to the public’s desire for retribution. When Obama introduced the Volcker rules and started talking about wanting to pick a fight with Wall Street, he was at last succumbing to this pressure.

The depressing coda to all this is likely to be financial reform that falls short of even Geithner’s plan. Partly this is because the administration didn’t challenge many of the constraints that were already in place. But mostly it is because even the biggest crisis since the Great Depression hasn’t changed Washington’s ideological outlook nearly so much as it has everybody else’s. Three decades’ faith in deregulation and the power of the market makes a lasting impression. Most members of Congress have enough political sense to criticize Wall Street bankers. But meaning it enough to push tougher reforms is still regarded as slightly unsophisticated, as the handful of congressmen who’ve tried can attest.

Before passing the administration’s plan, the House weakened oversight, carved loopholes for derivatives trading, and cut commonsense measures like one requiring financial firms to offer “plain vanilla” alternatives to complicated (and profitable) products like mortgages. The Senate seems poised to weaken things further. All of this happened as a wave of anger was gathering force. When it broke, with the Republican victory in Massachusetts, it seemed to finally sweep away some long-held illusions, causing many Democrats to realize how sharply at odds their beliefs are with popular sentiment. Only now, too late, are those beliefs beginning to ebb.

The economic recovery has eased the urgency for reform that existed a year ago. Even if the administration changed course and pushed for strenuous measures, Obama and Geithner probably lack the credibility to pull them off. What successes they’ve achieved are obscured by high unemployment and anger at Wall Street, reflecting the inadequacy of their stimulus and the fallout from their recovery and reform plans. “We managed the economic recovery like we were investment bankers,” a senior adviser to Vice President Biden complains. What chance there may have been for tough reforms came early in the crisis, when public anger was peaking and banks were weak, and any such reforms probably would have required someone other than Geithner, the face of the bailouts, as their champion.

Geithner doesn’t breed nuance of opinion. You’re either for him or against him, and popular sentiment leans strongly toward the latter. But it’s possible to view him as someone who was indispensable in halting the crisis (his understanding of Wall Street’s psychology was particularly valuable) while still doubting whether someone so steeped in the institutional cultures of Washington and Wall Street has the necessary distance to direct their reform.

The angry uprising that stopped the Obama agenda in its tracks is part of the steep political cost of following the Geithner Plan—a cost that seems to keep rising, even as the fiscal cost continues to fall. Even the most prominent indicator of recovery, the robust stock market, has come to seem a curse, by reinforcing in the public mind how quickly Wall Street has recovered while everyone else is left to endure. And Obama can’t really tout all that he’s done without also drawing attention to his gentle treatment of Wall Street.

Depending on your point of view, this is either a cruel or a fitting irony. By placing his chips on Geithner a year ago, Obama was betting that a strategy of growth under any circumstances was the right move, and that devising new rules was best left to insiders. But even Geithner isn’t sure that the public will come to see it that way: “In the end, what people care about is, what did you do? Did it make things better or not? That’s what you’ll be judged by. Now, will it vindicate the president over time? It should, but I’m not sure it will. I think probably not. The country is dramatically better off today. People say the financial strategy was politically costly for us. And I say to them, relative to what? Would it have been better to have the stock market where it was in March, the economy still falling, and unemployment much higher?”

History may yet judge Obama favorably. But it's entirely conceivable that the economy could outperform everyone's expectations of a year ago and voters will still punish him and his party. And, in fact, it appears ever more likely that that's exactly what's going to happen.